• Will

A Real Estate Guide To Investing In SMBs

A bit of a strange title, right? How does real estate investing have anything to do with acquiring small businesses ("SMBs")?


Well, generally speaking, it could be argued that real estate investing likely has very little in common with buying SMBs. They are totally different asset classes, offering different types of risk-adjusted returns, attracting different types of investors, while being most impacted by different internal & exogenous forces. However, if we step back and zoom out to 40,000 feet, investing is really just investing when you look at investing at this level. There are certain high-level “rules” and realities of investing that transcend geographies, asset classes and investors.


Additionally, though in an unrelated vein, I’ve found that being “creative” often has less to do with being endowed with certain skills or traits and far more with how one interacts, observes and connects with the world around them. For me personally, I have an insatiable appetite for reading - predominantly business and investing related topics, though I do specifically carve out time to explore a wider range of areas, be it science, space, travel, art, physics, etc. Now while I find reading about these varying subjects to be innately enjoyable, I also realize that exposing myself to a wide range of inputs, experiences, people, ideas...it allows me to often serendipitously find parallels and connections across things one would usually never think about tying together. It allows me to ponder possibilities I likely otherwise would never think to even ponder. That’s important & powerful, particularly for investing and in business in my view.


So, while discussing real estate investing alongside investing in SMBs isn’t as exciting perhaps as linking 19th century French impressionist art with the foundations of the relativity of simultaneity, there is still real benefit in learning about the investor mindsets, structures & strategies, for example, common within the large, incredibly liquid, fragmented real estate market and seeing if and how those learnings can inform one’s efforts in buying SMBs.


Before proceeding further, though, let’s refresh ourselves on a few key facts about the SMB market really across the globe today:


- It is massive...we are talking trillions of dollars in aggregate SMB revenue

- It is incredibly diverse & fragmented, made up of millions of SMBs

- It is inherently difficult for investors to effectively "tap into" this asset class, particularly at scale

- Almost every type of viable SMB investment vehicle today is not scalable (e.x. search funds)


So, with the above realities in mind, let’s now take a closer look at the very interesting story of entrepreneur Yat-Pang Au and his real estate investment firm, Veritas Investments. To try to keep a lid on the length of this post, I will direct readers to a brief overview article on Mr. Au and Veritas here. In short, Veritas is one of the largest residential landlords in San Francisco, with more than 5,000 apartments at an aggregate value of >$1Bn - a feat achieved from a relative standing start in the early 2000’s.


To make things a bit more "exciting", we’ll take a peek at a few passages from the above-linked article about Veritas and we'll slightly rewrite them to fit the realities of the SMB market. I think we’ll find a lot of overlap and, consequently, end up with a great “case study” of sorts in Veritas, as we think about a scalable SMB investing strategy. Ok, here we go:


Original:


“The smaller assets in San Francisco never garnered much attention from institutional investors, Au says. ‘It’s a combination of the assets are of small dollar value relative to what institutions are used to playing in; they tend to be older stock; and there are oftentimes regulatory issues as well as operational issues,’ he adds. ‘You can’t ­deliver services from an on-site team to a 20-unit building.’”


Revised:


“The smaller SMBs all around the U.S. never garnered much attention from institutional investors, Au says. ‘It’s a combination of the assets are of small dollar value relative to what institutions are used to playing in; they tend to be older stock; and there are oftentimes operational issues & individual limits to growth,’ he adds. ‘You can’t “move the needle” from investing in a 20-person SMB.’”


Hm, some interesting, general overlaps so far...and by the way, we are assuming a “20-person SMB” here broadly represents a “micro” SMB with $750K to $3M in free cash flow.


Original:


“To get around that fact, Veritas has built a platform to centrally deliver services to buildings with 20 to 30 units. ‘We believe our greatest strength is that we continue to institutionalize this small unit-count aggregation strategy that predominantly [involves] mom-and-pops,” Au says. “By doing so, we’re able to offer our investors a big opportunity to come in at a lower cost basis with higher operating leverage because we’re now at a platform at scale and can play in all parts of the capital stack, from equity to debt.”


Revised:


“To get around that fact, HoldCo has built a platform to centrally & specifically invest in SMBs with 20 to 30 employees. ‘We believe our greatest strength is that we continue to institutionalize this small unit-count aggregation strategy that predominantly [involves] mom-and-pops,” Au says. “By doing so, we’re able to offer our investors a big opportunity to come in at a lower cost basis with higher operating leverage because we’re now at a platform at scale and can play in all parts of the capital stack, from equity to debt.”


Notably, I’m barely needing to change much here - the highly successful approach & strategy Veritas is employing across “too small” apartment buildings seems quite applicable when thinking about investing in "micro" SMBs at scale.


Original:


“Also, unlike developers who build from the ground up, Veritas acquires buildings that are decades old and lack the amenities today’s renters are after. ‘We enhance amenities and shared-economy services that are able to provide that level of amenity package that our millennial demographic so desires.’”


Revised:


“Also, unlike private equity firms who acquire larger, more sophisticated companies with meaningful existing resources, HoldCo acquires SMBs that are sometimes decades old and lack the operational, technological & strategic resources today’s investors are after. ‘We enhance those resources & know-how so that we are able to provide that level of customer, employee & investor satisfaction that our stakeholders so desire.’”


Few more changes there, but the story is consistent across both - buy things others aren’t / can’t, improve them some & end up with a better outcome for all involved. It should be noted as well that Veritas generally buys to hold...precisely as we are proposing to do in the SMB space.


Let’s keep going…


Original


“Typically, ownership is fragmented when it comes to small assets, which makes the market as a whole inefficient. ‘So what we’ve done is capitalize on a fragmented asset class that’s nearly impossible for institutional investors to be involved with, because the dollars are so small on an ­individual-asset basis.’”


I don’t need to change anything here!


So, what point(s) am I trying to make?


At the most basic level, I'm arguing that one can loosely mimic Veritas’ overarching strategy and implement it within the "micro" SMB space with similar success.


Elaborating on that assertion, the Japanese SMB acquisition thesis we have previously proposed, while seemingly “new”, “unproven” and "unlikely to work" according to some, is, in fact, very much proven, likely to be quite successful & scalable and represents a massive, “untapped” opportunity if Veritas is any guide. Sure - Veritas falls outside of the world of SMBs and, as I mentioned above, there are myriad differences between the two asset classes; however, I’d also point to the likes of the multi-billion dollar market cap Indutrade in the Nordic region as an exciting “blueprint” executing a very similar SMB investing approach to the one we lay out (I haven’t been that creative on my own...a future post on Indutrade will be published soon). 


I’ll close with a perhaps quasi-controversial view of mine...there is an increasing lack of creativity among investors the further away from “tech investing” one moves - perhaps rightly so, but the fact nonetheless remains. Acquiring “old economy”, “micro” SMBs arguably falls at the complete opposite end of the spectrum to investing in "bleeding edge", frontier tech startups - so, there isn’t much in the way of free-flowing creative juices in and among most SMBs & typical SMB investors. As a result, there is something to be said for (as well as potentially sizable latent returns laying in wait for) those willing & able to look outside of immediate adjacencies (i.e. the standard private equity playbook), across “borders” (e.x real estate, as we did here) & into the “world of the new” (e.x. tech startups & VC) to consider innovative, "new" ways to build scalable value & returns in the otherwise overlooked, siloed, non-scalable SMB universe.

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